CFO | IASB questions new asset impairment rule

It is hoped a new way of impairing assets spurred by the financial crisis will lead to earlier and more adequate levels of provisions, as well as reducing the effect of accounting rules on the financial cycle, but the accounting standards setter questions the real impact the change will have.

The International Accounting Standards Board (IASB) is changing the way the impairment of assets should be calculated from the so-called incurred loss method, to the expected loss method.

The IASB will release a second exposure draft on their approach in the second half.

The new method will have the biggest impact in the financial sector, but it will require all companies to try to predict the losses on a financial asset when it is created or acquired and hold an “allowance balance" or provision against it.

The incurred-loss method requires a provision to be made only when there is evidence of something that will devalue that asset. For instance, if there were a default on a loan.

“The new model says there may or may not be a default, but based on my experience of my whole portfolio, I know something is going to go bad over its life, I am going to provide a provision – I don’t have to wait for a default," Ernst & Young’s IFRS expert, Lynda Tomkins explained.

Companies will also have to take into account present market conditions and use forecasts based on these to calculate potential losses over the life of the asset.

“The overall impact is it will bring impairments on earlier compared to today and so [provisions] will probably be higher than they are today," she said.

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By making those provisions earlier, prudential regulators are hoping that it will reduce the amount of accounting impairments made during a major economic downturn. It was argued that fair value impairment of assets during the financial crisis exacerbated it.

But IASB chairman Hans Hoogervorst said it was clear the market felt there was strong evidence that bank balances have inadequate asset provisioning as their book values have stayed so much higher than their market capitalisation. But he said the effectiveness of the change will rely more on the judgement of those making the impairment decision and questioned the real impact of the change.

“The expected loss model relies to some extent on judgement," he told an accounting conference in Frankfurt on Monday.

“Before the present crisis, many banks and their supervisors obviously were not able to perfectly anticipate risk. Even where the writing that warned of a full-fledged credit orgy was clearly on the wall, the magnitude of problems to come was not predicted."

Spain’s banks employed a form of expected loss provisioning before the present crisis called dynamic provisioning, he said, but this failed to predict the size of losses.

“Since the outbreak of the crisis, Spanish banks have written off assets to the amount of some 18 per cent of GDP. Some think that more is still to come. The dynamic provisioning of the Spanish banks was completely overwhelmed by the magnitude of these losses.

“The lesson is that economic cyclicality can be too powerful to be dented significantly by mere accounting."

But he said the introduction of the expected loss model should lead to provisions being made in “a more timely and realistic fashion and lead to more forward-looking risk awareness in the financial industry".

Tomkins said non-financial companies would be effected as well, but to a lesser extent as they don’t hold the same level of financial assets on their balance sheets.

She said the IASB has said there will not be a major practical change for companies, but given the shift in approach there will be some change, she said. “I think there could be some slight increases in their levels of impairment."

“I think for banks there is going to be a lot of change in their systems to collect information that they may not collect today," she said.

“They may need to involve different levels of management and different assessments of data than they do today – what could be the impact because of the changing unemployment data, or the change in the interest rates and how could that change their past historical loss rates."